The 10 November New South Wales Report On State Finances 2007 - 08 described how one month of electricity trading blew a hole in its 2008 budget, big enough to put it on negative credit watch.

What went wrong: its electricity retailers were obliged to pay an average price of about $250 a megawatt hour, instead of about $30. The budget home was over $3 billion; - and described as caused by electricity guarantees; it appeared the guarantee was half of the value of the hole. The difference was not clear.

State guarantees: The State provides a guarantee over electricity related settlement payments. State -ordered Vesting contracts require a swap; but it appeared the State may have run short of cash to pay the intermediary, NEMMCO. Credit risk for these activities was $1.3 billion (2007: $1.6 billion). The paper described June 2007 NSW Derivative Electricity Hedging Contracts this way:

After the wash-up, $334 million found a new home: ‘$334 million million of electricity liabilities at 30 June 2007 have been reclassified from other liabilities to payables to reflect the nature of contractual obligation as a payable’.

'Corporations did it, not Treasury': "It is the policy of state-owned electricity generators to hedge their risk associated with fluctuations in the sale price of electricity into the national electricity market’.

How they did it: ‘This is by entering into derivative contracts with wholesale electricity market counterparties. These derivatives are marked to market and their fair values are measured based on industry accepted valuation methodologies and a forward curve, in accordance with AASB 139 Financial Instruments: Recognition and Measurement.

Drought, gas outage: ‘The fair value of electricity derivative contracts as at 30 June 2007 reflected high market prices, in both the spot market and extremely volatile forward pricing of electricity’.

June 2007 blew $3b hole in 2008 year: ‘This was due to a combination of factors, including the prolonged effects of drought conditions, supply interruptions particularly in the last quarter of the financial year and increased demand, a result of very cold weather in June 2007. These factors improved during July and August 2007, with a corresponding reduction in spot market prices and the electricity forward price curve falling significantly. As a consequence the fair value of electricity derivative liabilities decreased significantly in the 2007-08 reporting period’.

How the state registers electricity risks: ‘The state manages exposures to fluctuations in electricity market prices through the use of various types of electricity derivative contracts in accordance with approved policies’. The policy: ‘Overall the hedge objective is to reduce variability in cash flows caused by electricity wholesale prices and volume risks.;

- gain or loss from remeasuring the hedge instruments is deferred in equity in the hedge accounting reserve;

- to the extent that the hedge is effective; and

- reclassified into profit and loss when the hedge electricity revenue is recognised.

- the ineffective portion is recognised in profit and loss immediately.

During June 2007: ' ...very cold weather and high demand resulted in price spikes to the spot price for electricity. This led to significant remeasurements for electricity derivative asset/liabilities and the hedging reserve during 2006-07, which reversed during 2007-08 as the spot prices returned to more normal level

June 2007 dissections: These were posted ‘into amounts held for trading and amounts effectively hedged have been reclassified to reflect that the majority of the electricity derivatives were effectively hedged at June 2007.

$334 million finds new home: ‘$334 million million of electricity liabilities at 30 June 2007 have been reclassified from other liabilities to payables to reflect the nature of contractual obligation as a payable’.

NEMMCO Guarantees: The State provides a guarantee over electricity related settlement payments made by electricity agencies to the National Electricity Marketing Management Company (NEMMCO) and power generators. Settlement payments are normally four weeks in arrears for $1.3 billion (2007: $1.6 billion)'.

Electricity liabilities: ‘The NSW Treasury Corporation has issued unconditional payment undertakings on behalf of some New South Wales government authorities participating in the wholesale electricity market to pay to the system administrators any amount up to an aggregate maximum agreed with individual participants. The Corporation has also issued undertakings on behalf of other NSW government authorities in respect of those authorities performance under contracts with third parties. Amounts paid under these undertakings are recoverable from the NSW government authority participants. This financial accommodation is government guaranteed. At year-end the agreed aggregate amounts totalled $1,327 million (2007 $1,587 million)’.