Draft ESEM contract terms – Electricity Contract Co-Design Working Group
The Electricity Contract Co-Design Working Group (Working Group) has released its consultation paper on the proposed Electricity Services Entry Mechanism (ESEM) contracts (Industry-led Electricity Contract Co-Design Consultation Paper).
Submissions are due by Friday 2 October 2026. The Working Group has asked for responses on a series of consultation questions and established a response portal (ESEM Contract Co-Design Consultation Survey).
Fundamentals
The Working Group has relied heavily on the following principles from the NEM Review Final Report recommendations:
- The ESEM should be used to procure bulk energy, shaping and firming services.
- The ESEM should allow new electricity service providers to compete for standardised, fungible contracts. These contracts would offer stable income streams tied to the delivery of defined electricity services, helping providers finance new projects.
- Contracts should not be issued for the years a project is able to secure them in-market. Rather, contracts should be issued for the later years of a project’s life, allowing electricity service providers to sell their output to retailers or commercial and industrial (C&I) users for the period of time that the market can manage risks effectively.
- The standardised, fungible contracts should be sold back into the market at the point in time that allows retailers and C&I users to manage energy market risk, supporting retail competition.
The products are proposed to be structured as financial instruments under an ISDA Master Agreement framework, with no physical performance obligations. The products are intended to be fungible and tradeable.
Overarching comment
In our view, the key design principle applied is that the ESEM contracts are to be fungible, firm and not linked to assets.
The Working Group recognises that this will significantly change the risk profile for developers of new projects from the current financing expectations and is looking to achieve a bankable outcome. There is an open question as to whether this can be achieved.
How do the contracts for the services operate and what are the issues
Bulk energy: Regional Reference PPA
How does it operate?
This product is based on a swap structure. It works by fixing the price received by the Seller per MWh of output, where the notional quantity is determined by using the Reference Production Index (which is based on the performance of a reference fleet of renewable projects within the relevant NEM Region).
The Reference Production Index is proposed to be set by the performance of the Reference Fleet, which contains all operational projects of the specified technology within the specified NEM Region with a Nameplate Capacity of 30MW or greater. It is proposed that mechanisms will be included to manage changes to the Reference Fleet over time, balancing risks for both buyer and seller.
Issues – our perspective
Reference Fleet
The key issue with this product is the composition of the Reference Fleet, and whether the Reference Fleet is static or adjusts for new generation over the life of the agreement.
We are aware of products being available in the marketplace using AEMO data to determine a regional wind-weighted price, but these are for short-tenor contracts.
The challenge for this contract is whether the developer can "beat" the Index and do so for the life of the contract.
Negative prices
The product does not yet deal with the treatment of Trading Intervals where the Floating Price is less than $0/MWh. Choices seem to include:
- a knock-out mechanism where there is no settlement; or
- settlement based on a $0/MWh floor.
There is a suggestion by the Working Group that a floating price cap be applied and the cap be set at $600/MWh. It is unclear how this will operate and who has the benefit of the floating price above the cap price (it seems it would be the seller).
Green products
Green products are likely to be excluded, so developers will need to enter into contracts with third parties (although it is unclear whether this could include data centre operators, given some of the recent announcements surrounding data centres). For a fungible contract which is not asset-based, this is an understandable approach but represents a departure from the typically bankable structure of a "bundled renewable contract".
Force Majeure, marginal loss factor and constraints
All at the Seller's risk – see comments below.
Shaping: dynamic time of day block spread swap
How does it operate?
The dynamic, time of day block spread swap uses an ex-ante, dynamic approach to defining the forecast optimal periods for discharge and charge ahead of time. It is proposed to use an arithmetic formula to determine the trading intervals to be included in the Discharge Period and the Charge Periods.
The product is settled by comparing the actual spread settled against an agreed fixed spread for a day calculated ex-post where:
- the actual spread is the average spot price for the specified discharge trading intervals minus the average spot price for the specified charge trading intervals; and
- the agreed fixed spread is an agreed amount in $/MWh.
Issues – our perspective
The setting of the Daily Shaping Period
There is a lot of detail to be finalised in the method for determining the Discharge and Charge Period(s), including:
- how it is to be calculated;
- when the period(s) should be calculated and published (the current proposal is a day ahead at the time of NEM pre-dispatch);
- whether the period(s) should be contiguous or non-contiguous (e.g. a single 4hr block vs. 4 x 1hr blocks); and
- minimum time allowances for charging before a discharge period starts.
Defending the position
Given the shaping periods are set well ahead of time, physical plant can defend the position. But as the market moves over the course of the day, will these periods match the most economic time to charge or discharge?
There are significant changes in NEM pricing and trading over the course of a day, which are likely to result in significantly different outcomes from those predicted. This is likely to lead to some interesting trading outcomes.
How do parties such as intermediaries (even the ESEM Administrator), who do not have plant, defend their position?
Degradation
At Seller's risk. For a long-term shaping contract, this is a significant risk. If the contract does not include a degradation curve but rather a median outcome, then there is a "skewing" of revenue where later years will be impacted, potentially affecting bankability.
Force Majeure, marginal loss factor and constraints
All at the Seller's risk – see comments below.
Firming: $600/MWh cap contract
How does it operate?
This operates as a conventional cap, and the structure is well known in the market. However, where traditionally the strike price for the cap in the NEM has been $300/MWh, it is proposed to be $600/MWh.
Issues – our perspective
The strike price
The Working Group suggested a $600/MWh strike price was preferred because it allows sellers to retain greater merchant revenue opportunities under the cap, which is expected to reduce required premiums while preserving value for buyers. The $600/MWh level also aligns with the current Administrative Price Cap setting, limiting buyer exposure in prolonged high-price events.
In our opinion, from a bankability perspective, there are real questions as to whether financiers will place value on the "merchant opportunities" created by the increased strike price. Our expectation is that financiers will place greater weight on the fixed amount or premium paid for the cap.
Force Majeure, marginal loss factor and constraints
All at the Seller's risk – see comments below. However, this is a typical feature of a cap contract.
General observations
Force majeure and other interruption events
The ESEM scheme is designed to promote the development of new assets. Typically, over the last 10 years, these types of developments have been financed on a single long-term contract basis backed by the asset. Reflecting this position, the contracts have provided for relief for events like force majeure and constraints (the best example is the run-of-plant power purchase agreement for a variable generator).
In the non-renewable generation market, we have seen the "firmness" risk managed by things such as:
- cross cover, outage insurance products or even weather derivatives;
- portfolio positions;
- reduction in volume to leave some merchant capacity to manage the risk; and
- integration.
These are not products or outcomes typically seen for single assets or participants in the renewable/energy storage sector.
Consideration could be given as to whether, utilising the underlying ESEM contracts, there is a contract position that can be offered to applicants to mitigate these risks.
Bankability
Bankability of these contracts is a key issue and is recognised by the Working Group. We think significant road testing of the contracts, and even trial financing, might be required to help these contracts become accepted by the finance market.
Recommendation – participate in the consultation
We strongly recommend that market participants provide feedback to the Working Group by 2 October. We have highlighted some issues in this note that could form the basis of a submission and would be comfortable elaborating on them.
Authors: Dale Gill, Partner; Paul Newman, Consultant and Isabelle Jardine, Graduate.
