Energy - Julian Amos

The Cost of Power - Part 2 The Tasmanian Experience

Details: Created on Thursday, 03 November 2011 11:00; Written by Julian Amos

Part 1 examined the development of the NEM (National Energy Market) from a national perspective.

In Tasmania, three utilities were created from the disaggregation of the old Hydro Electric Corporation (HEC). Hydro Tasmania was to be responsible for power generation, Transend for high voltages transmission, and Aurora for distribution (poles and wires) and retail sales. An arbitrary distribution concerning the allocation of the old HEC debt landed Hydro with over $1000m, and Aurora around $350m. Transend was debt-free.

The later addition of the Basslink cable has connected us with the mainland and enabled full participation in the NEM.

Hydro generates most of its power from water, and unlike thermal generators, can adapt to rapid changes in demand in quick order. As long as the water is there, Hydro can be a significant player in the NEM. Even through the drought, when water storages were low, Hydro was still able to provide power into the grid and pay its loan guarantee fee to the State.

Hydro derives its income from NEM market sales, arbitrage over Basslink, and its consulting business, Entura. It also has a successful and growing retail business on the mainland called Momentum, servicing a niche market for clean energy.

For some years, especially during the drought years, the interest payments on the debt allocation significantly constrained Hydro’s operations, including essential maintenance of its generating assets. In 2008, the government shifted some $220m of debt over to Transend, enabling Hydro to operate more efficiently. The advent of the “carbon” tax will be of competitive advantage to Hydro, essentially by making its coal-fired competitors less competitive. A great opportunity for its Momentum business.

First and foremost, Hydro is a business. It competes in a national market, and the price it charges for its power is determined by the market, and a regulatory oversight ensures it provides power at market prices. It provides major customers with bulk power under 24/7 take-or-pay contracts, and, although disbelieved by some, is charging commercial prices for that power.

To me, Hydro has been an outstanding success story. It has managed our water resource well, it has developed a successful wind-farm business, it has adapted to changing circumstances, it has become a successful trader in a national market, its business model of being a renewable energy business has provided it with competitive advantage, and its consulting arm is recognised throughout the world bringing renown to Tasmania. And it provides substantial dividends to the State.

Transend had the good fortune of starting its life debt-free. As a monopoly business it is tightly regulated, and its opportunities to value-add are limited. Transend’s revenue is derived from a revenue reset mechanism, whereby the price charged relates to the value of the assets under management. The higher the asset value, the more it is paid. In other words, it is in Transend’s interests to have high-value assets, as distinct from appropriate assets. It has in the past followed an extraordinary risk-averse strategy, with little evidence of business rigour. Compare the increase in its charge rate (71%) against the CPI (21%) since 2003. And staff numbers from 50 to over 300. Maybe the reset mechanism needs a reset.

Government should also seriously consider transferring the poles and wires business from Aurora to Transend. Bringing the regulated monopoly power delivery businesses together is a natural fit and could deliver synergies and cost savings resulting in cheaper power prices.

A new Chairman and CEO must deliver more commercial rigour to Transend’s operations. In fact, Government must insist on it.

Aurora is responsible for the distribution and retail sales of power. It buys power on the open (wholesale) market, which has significant price fluctuations, but needs to sell power at fixed prices. It must therefore embark on a sound risk management profile in order to remain viable. At the same time, it is at the cutting edge of our concern about power prices. However, demands for concessional rates are in fact community service obligations that should be paid for by government. In other words, Aurora should be allowed to run as a commercial business and pay a dividend to the State, which then determines how that money should be spent.

Government gifted Aurora an onerous legacy in the Tamar Valley Power Station. A new gas-fired station, it was half-built when its owners went broke. The government purchased it, paying far too much for a distressed asset, then handed it to Aurora to complete the build. To its credit, the task was completed on time and on budget. However the station was an expensive construct, and the debt still needs to be serviced. Furthermore, Aurora then “negotiated” an onerous take-or-pay gas supply contract, which has made the station an absurdly expensive operation to run.

More concerning is the approach the company has taken to its computerization program. It is common knowledge that there was a $50 m overrun implementing new billing software. A disaster, true blue. The reasons given were “we underestimated the task”. Maybe we have overestimated the skill of its senior management. And no further action has been taken – where is the accountability?

The Aurora business model is in need of some review. By its actions, it is obvious that Aurora is still searching for its niche. Is it a “poles and wires” business, a retailer, a generator, and to what extent should it be a national trader? All important questions.

Some folk remain critical of these entities – if a government business makes money it is at our expense, if they are losing money we have to subsidise them, again at our expense. Whichever way we look at it we lose. In my view, this is not the correct approach.

Throughout this article I have endeavoured to paint a picture that these utilities need to be run as businesses. The NEM has caused our utilities to be businesses. They may be owned by government, but they are commercial entities operating in a competitive national market, and need to be given the freedom to do so. Performance is a matter for their Boards. That is where the focus of their boards and management must lie. Questions about performance are really questions about their governance.

There is a regulatory oversight to ensure they operate in a fair and proper manner, but at the end of the day their task is to return a profit and pay a dividend to the State. The role of government should be limited to its relationship with the Boards. And no more. It is then up to the government to determine how that dividend should be spent.

Hopefully the review will come to the same conclusions.

The Cost of Power - Part 1

Details: Created on Wednesday, 02 November 2011 11:00; Written by Julian Amos

Power prices continue to rise, and the public are demanding a better deal. An act of political appeasement with the Greens has led to an inquiry to review the operations of Tasmania’s three power utilities. It has now taken over 12 months, it is forecast to cost taxpayers over $3 million dollars, it has distracted the utilities from their main game, and its report is now well overdue. Has it been worth it?

It all began with the National Competition Policy, established in the late 90’s.

By 1998, all state–owned electricity utilities were broken up (disaggregated) into separate generation, transmission and distribution/retail companies. In each of the mainland states a number of generation and retail companies were created. The purpose of this national policy was to create competition and therefore lower prices. States complied, because they would be penalized (by reduced payments from the Commonwealth) if they did not conform to this new policy. A separate management company (NEMMCo) was then created to oversight the behavior of these companies in a newly-created National Energy Market, or NEM. Has this policy worked?

Victoria embraced this policy with gusto. It broke up the old SECV into a number of different entities, promptly sold them and made a killing. The buyers thought they would also make a killing but soon found out it was not to be, and after many changes of hands, the present owners of these assets are managing them as best they can.

The same could not be said for New South Wales and Queensland, where the entities created from the breakup of the old utilities remained in public ownership. Unfortunately for them, the long-awaited efficiency improvements and price reductions did not occur.

The NEM plan involved generators bidding blocks of power at particular prices into a ‘market’, and for retailers to buy the lowest-priced bids in the market. The theory being that the generators would bid in as low as possible, in order to sell their power in the market, and thus provide retailers with low-priced power, which they could then provide to their customers, again in a competitive environment.

Practice does not always follow theory, and for some years, both generators and retailers struggled to come to terms with this new market-based reality. Lack of proper risk management structures in the trading environment have caused grief to a number of players, especially when the market has been volatile, such as hot days, generators (gen-sets) going down etc. Practice eventually began to conform to the theory, but hiccups have continued to occur.

Private companies that were operating at that time found they could generate power in one State and sell it in another, and so they began to buy up strategic assets. This was not foreseen by the planners at that time. In fact no sooner had disaggregation occurred than a de facto re-aggregation (vertical integration) began to take place with generators buying retailers to become ‘gen-tailers’ and sell directly to customers. This mitigated risk. A single generator was at risk from a collapsing or rapidly varying bid price, and the retailer from a varying market price for purchase, yet having to provide a fixed price to the customer. Having a foot in both camps mitigates these risks.

The breakup of the public assets began to look like a transfer of those assets to private hands, using the mechanism of a national electricity market to do so. By default, public policy appeared to suggest a transfer of public involvement from power operations to power regulation through NEMMCo.

Most mainland generators are coal-fired power stations, and their interest is to run their gen-sets at a constant rate and thus to provide a constant amount of power into the grid - in other words to provide base-load power. Hydro stations, whilst also being good base-loaders, are better equipped to turn their gen-sets on and off with fluctuating demand, and thus better equipped to provide peak-load power.

Wind and solar, small beer in the grand scheme of things, can provide neither, due to the vagaries of the weather, and whatever benefits are provided by being “renewable” is both prohibitively costly and inefficient as there is always back-up required. So thermal gen-sets have to be operating anyway. However, in conjunction with hydro, these renewable energy sources can provide power into the grid as and when, with hydro acting as a backup battery, a sensible synergy. Well sensible if we ignore the massive cost burden new renewable forms of generation create; a little discussed fact being that wind power is 3-4 times as expensive as power from a coal-fired power station and this alone will dramatically increase power bills if Australia reaches its target of 20% of its power from renewable means by 2020.

The new federal government initiative of putting a “price on carbon” - in reality carbon dioxide the gas - emissions, will now impose an additional tax regime on coal-fired generators. Many coal-fired generators are now considering getting out of the generation business altogether, and a number have responded to the Federal Government calls for Expressions of Interest to do so.

The Federal Government hopes that “cleaner” energy sources, such as gas, will replace coal-fired generation, but the policy remains unclear, and a sudden departure of existing generators from the scene could cause problems in reliability and capacity to supply. For example, Hazelwood, a brown coal generator targeted for closure, produces some 20% of Victoria’s power.

So, public money will now be spent to assist those leaving, more public money will be spent encouraging new entrants (note that gas is at least 50% more expensive than coal), and yet further funds will be spent to subsidise inefficient forms of energy production. At the same time the power supply system has become less reliable and less secure. One is left to wonder whether the public has benefited at all from the policy of disaggregation trumpeted as the new era of competition only 15 years ago.

Tomorrow Part 2 The Tasmanian Experience